The Cost of Doing Business in SBA Lending

I’ve always wondered why in banking no one ever talks about the cost of operating a line of business. We discuss credit decisions to great lengths, along with loan policies, compliance, IT security, etc. But no one really talks about the cost of doing business and what the bank ultimately needs to do to make money. So let’s talk about it.

Any business, banks especially, have overhead such as facilities, equipment, furniture, insurance, IT software, and security. These are fixed or semi fixed costs, whether your bank has an SBA department or not. So if you’re going to add an SBA department, the added costs are mostly personnel, which would be an SBA Business Development Officer (BDO), an SBA underwriter, experienced SBA processor and someone who can handle post close SBA loan servicing. Depending on the geographic location, the cost of adding said personnel will vary greatly. I can tell you from experience that a capable BDO will cost around $120k annually, plus commission, an underwriter is about $120k annually, and an experienced processor is generally paid around $70k annually. We will leave servicing out of this discussion for now. So your core SBA staff costs are roughly around $310,000 annually.

Now let’s talk about revenue. Let’s say your SBA BDO generates $10,000,000 in SBA loans in a year and the bank sells the 75% SBA guarantee on all those loans. With $10,000,000 in loan production, the bank can sell $7,500,000 guaranteed portion at an estimated premium of 10%, creating a $750,000 premium or gain. The bank also made interest income; let’s use Prime + 2.0% or 10.5% today. I am assuming the bank made these loans throughout the year, so the bank will end the year with $2,500,000 in unguaranteed pieces of SBA loans. Since the loans are funded evenly over the year, the average loan balance for purposes of calculating interest and servicing income, is half of the unguaranteed balance or $1,250,000. That number multiplied by 10.5% equals $131,250. Let’s assume a cost of funds of 4.0% or $50,000, so the net interest income is $131,250 - $50,000 = $81,250. The bank also made Servicing income of 1.0% on the amount sold (averaged for the year); $375,000 X 1.0% = $37,500. So the total income for the bank is as follows:

SBA Income

Loan premiums           $750,000

Net interest income    $  81,250

Servicing income         $  37,500

Total Income               $868,750

SBA Expenses

Staff cost                     $310,000

BDO Commission        $100,000 (Assumes 1.0% commission)

Loan loss provision      $    5,000 (Assumes 2.0% on $2,500,000 unguaranteed portion)

Total Expense              $415,000

Total Net Income        $453,000

Now what happens to this model if your BDO only produces $5,000,000? There are some key considerations that need to be factored into this discussion. One factor to consider is the percentage cost (%) to the bank to generate $10,000,000 in SBA production. That is calculated as follows, ($415,000 expense / $10,000,000) = a 4.15% cost for production. Part of this is amortized over the life of the loan, per the accounting requirements, but for our purposes it is good to know that number. What do these numbers look like with a production drop of 50%? The income side will be cut in half, as are the commissions and provisions. That means income will be $434,375 and the expenses are $362,500, for a net profit of $71,875. This number is far less impactful for the bank. But look at what happens to your cost of production ($362,500/$5,000,000) = 7.25%. Most banks would look at the small profit that they made, but not consider the high percentage cost to generate that income. What happens if the BDO you hire doesn’t produce at all? That means not only have you lost money paying for a salesperson that didn’t produce, but also for a loan processor and underwriter.

When starting an SBA operation, there are many factors to consider, especially the cost of doing business. This is why the LSP model makes sense if your institution is interested in getting into the SBA business, but unsure of your production capability. A quality LSP vendor relationship allows you to create an SBA department on a variable cost basis, without the risk of committing to the staffing overhead. Under our variable cost model, it doesn’t cost the bank a penny to sign up and to have an exceptional SBA team at the ready for when you do have an SBA request. Under our variable cost pricing, a lender makes money if they do one loan (or twenty) and for a far lower cost than what I have outlined above. This also allows you time to learn best practices from us for when you have enough SBA activity to support your own internal operation.

 Written by Brian Carlson

Three Reasons Why Lenders Should Make SBA Part of Their Strategic Plan

Total SBA is a leading Lender Service Provider, offering nationwide support to financial institutions in their small business lending operations. Our team of experts can help you build a profit center with an efficient SBA lending platform. With the right support, your institution can give customers much needed financing options, while increasing your bottom line without incurring additional overhead. There are many advantages to SBA lending - let Total SBA show you how you could be utilizing it to full potential.

SBA PROFITS

Most financial institutions are struggling to grow deposits - so what is the most profitable way to serve your clients and maximize use of your institution’s liquidity? Suppose in 2024 a lender funds $10,000,000 in SBA 7a loans and sells the $7,500,000 of guarantees. They would end up with $2,500,000 of loans. Therefore, the lender has only used a small number of deposits to generate $10,000,000 in loans for their clients.

PROFITABILITY

In today’s market, the lending in the above example should earn at least 9.0% premium on the $7,500,000 of SBA guarantees sold, or $675,000 in gain. The lender also gets to keep a 1.0% interest strip on that $7,500,000 in guarantees sold, or $75,000. If your net interest margin is 5.0%, then the lender will earn another $125,000 on the $2,500,000 of unguaranteed loan portions retained. In reality, the loans will probably be funded evenly over the year so the accrual of interest and servicing if averaged would be half of those numbers. But still, the lender will have generated $675,000 in gain on sale, $37,500 in servicing and $67,500 in NOI, totaling $775,000 of profits on $2,500,000 in retained balances.

RISK MITIGATION

Given the current economic conditions and high-rate environment, many borrowers are stretched and often the only way to help them is through the longer amortizations and flexible terms available through SBA. Plus, the lender may need the SBA guarantee to mitigate the higher risk that exists with some businesses. Lastly, the SBA PPP program was understandably popular with borrowers and now those businesses are expecting lenders to offer SBA programs to help them grow their operations.

By utilizing Total SBA, a financial institution can immediately create a highly profitable SBA program without any overhead expense and at the same time provide needed services to their business clients.

Written by Brian Carlson

SBA 7a Collateral requirements.

There are several common misconceptions about collateral requirements and SBA loans. In fact, I frequently talk to borrowers (and bankers) who falsely assume that the SBA is going to take a lien on everything they own.

The reality is that the SBA wants enough collateral to secure the loan if it’s available. Contrary to popular belief, if there isn’t enough collateral available to secure the loan and the bank feels comfortable with the loan request, they can still make the loan.

To demonstrate, let’s say you have a Dentist that wants to buy a business for $1,000,000 that has $250,000 worth of equipment collateral. The rest is goodwill assuming the borrower does not have equity in a home that could be pledged. In this scenario, the loan is eligible with only the $250,000 of equipment. Conversely, if the borrower had a home worth $1,500,000 owned free and clear, the SBA would require that the bank take a lien on the house.

In the recent changes made to the SOP, the Small Business Administration now states that loans under $500,000 can use the same collateral guidelines as commercial loans. This means that if your bank’s lending policy only requires taking business assets and does not require taking a personal residence, then you can do the same for your SBA loans.

Article written by: Brian Carlson

In what situations does an SBA guaranty make a loan viable?

Years ago when I was starting out in commercial lending, I would hear senior lenders talk about using an SBA guarantee to shore up a loan. This leads to an important question: when does it make sense to use an SBA guarantee to mitigate risk?

We all know the basics of commercial lending, in that, you want to have a primary and secondary source of repayment, and evaluate the following credit components to make a loan:

 1. Experienced management

2. Good repayment ability

3. Collateral

4. Good borrower credit

5. Appropriate down payment/borrower net worth

 In general, the guarantee can’t help you if you have weak management, no historical repayment ability, or poor borrower credit. These are key fundamentals of a loan; and while the SBA guaranty can limit your loss, lack of the above-mentioned components increases the risk of making the loan. Also, the SBA guaranty is a partial secondary source of repayment, the bank still has 25% of the loan at risk.

 Nevertheless, the guarantee clearly provides an enhancement to collateral, as 75% of your loan is insured. It also helps to offset risk if you have a lower down payment, since SBA is subsidizing 75% of any loss. Therefore, lower down payments or lack of collateral are typical weaknesses where lenders can use the guarantee to reduce their exposure.

 You might be asking: what about start-up loans?  The SBA and community bankers like the idea of being able to help borrowers start a business, but it does create a much higher risk profile. A start-up relies heavily on management ability, and as a new business with projected income, what are your primary and secondary sources of repayment?

 The SBA is a great program and certainly enhances the bank’s ability to help more borrowers, but it’s important to consider when it’s appropriate to use it to make a loan bankable.

Article by: Brian Carlson

Benefits of Using SBA Loans for Business Acquisitions

We frequently see the SBA 7a loan program utilized to finance the purchase of a business or used for a partner buyout. It makes sense since the SBA allows a 10-year amortization of these loans, while most financial institutions will only provide 5-year loan terms for a business acquisition. Not only does the 10-year amortization make it easier to achieve an acceptable debt service coverage, but the 75% SBA guaranty significantly reduces the bank’s exposure.

The SBA guaranty is especially important with a business acquisition, since the value of the business cash flow creates a goodwill portion of the loan, which can’t always be covered with outside collateral. With a 75% guarantee, at least 75% of the loan is collateralized.

On a business acquisition, we normally see a borrower that has strong management or business ownership experience in the industry of the subject business. If the business is a facility-based business like a hotel or gas station, we generally expect to see good cash flow with debt coverage around 1.25 to 1, up to 1.5 to 1. This is because the acquisition includes the real estate and the business generates its income based on location and demographics of the area. For acquisitions where just the business is being purchased, we generally see a debt coverage of 1.5 to 1 and higher.

In addition to strong management and cash flow, most lenders look for borrowers with clean credit and relative strength in their personal net worth. It is also important that the borrower has adequate post close liquidity to support the business during the transition of ownership.

Business acquisition loans are a great way for a financial institution to grow its C&I portfolio and mitigate its risk, while at the same time providing the borrower with a loan term that enhances their cash flow.

Article by: Brian Carlson

Advantages of SBA Lending When Buying CRE

 A key benefit of the SBA lending program is that it allows a much lower down payment for business owners when purchasing real estate. Under the SBA 7a program, a borrower can put as little as 0% down on a CRE purchase or construction project. Obviously, this would have to be a strong borrower and subject to your institution’s Credit Department.

 It is very common to see banks offering up to 100% SBA financing - since their risk is reduced with the 75% SBA guaranty. If a borrower can put 15% down the SBA considers the loan fully secured and will not require any additional collateral. In this scenario, the benefit to the borrower is clear when compared to a conventional loan’s 25% to 30% down payment requirements. On a $3,000,000 CRE purchase, the borrower might put 10% or $300,000 down, compared to $900,000. Not only does this make the CRE purchase a more viable opportunity for your client, but also leaves them with working capital to continue growing their business.

 Let’s look at this from a financial institution’s risk perspective. Let’s say the borrower ultimately defaults and the institution has to foreclose and resell the property with a 50% recovery or $1,500,000. If it is a conventional loan with $900,000 down and a $2,100,000 loan balance, the loss is $600,000. But if the borrower puts down 10% or $300,000, then the balance is $2,700,000. Again, the recovery is $1,500,000, so the loss is $1,200,000. However, because the SBA guarantees 75% of the loan, the loss is 25% or $300,000, which is much better than the result on the conventional loan.

 The calculation varies with the recovery on the property, but the higher rate and gain on the sale of the SBA guaranty make the return significantly higher than conventional loan yields. This is an example of how the SBA guarantee can enhance institutions yields, without taking on more risk.

Article by: Brian Carlson

Debt Refinancing with SBA

One of the many benefits of SBA lending is the ability to refinance debt, including existing commercial loans at your bank. We often see debt refinancing as a component of an SBA loan, where the borrower is trying to expand their business or restructure debt to improve cash flow. Because commercial real estate debt can be financed over 25 years (and up to 10 years for business loans), refinancing existing debt into an SBA loan can often improve a borrower’s cash flow.

To illustrate how this works, suppose you have an existing bank client that has a $1,000,000 line of credit that is fully extended. Then consider that the business needs more capital to continue to grow but the bank isn’t comfortable increasing a conventional line. One option would be to refinance the existing line into a 10-year SBA term loan. This would reduce the bank’s risk with a 75% SBA guarantee and would allow you to extend the borrower a new $350,000 express line of credit, which has a 50% SBA guarantee.

In this situation the bank has lowered its risk on the original $1,000,000 line to $250,000 of unguaranteed exposure on the SBA term loan and $175,000 on the express line. In this scenario the bank has supported the clients cash flow needs, but also reduced its risk from $1,000,000 to $425,000. In addition, the bank can likely sell the 75% guaranteed portion of the $1,000,000 term loan for around a $75,000 premium.

There are many ways to continue to serve your customers in today’s market while reducing risk to your institution. Providing solutions through SBA loans is a mutually beneficial way to improve liquidity for you and your customers.  

Article by: Brian Carlson

The importance of SBA lending in the current Banking environment

SBA Profits

Given the recent events in the banking industry, SBA lending deserves a second look for the advantages it offers. The key to SBA 7a lending is that the government guarantees 75% of the loan and this full faith guarantee is easily sellable on the secondary market for premiums recently as high as 15%.

Liquidity

Aside from its earning potential, the liquidity component of SBA lending is especially valuable right now, given the high cost and scarcity of deposits. Unlike traditional commercial real estate loans or C&I loans, which cannot be easily sold or participated, SBA loans can be sold immediately and without any buyer re-underwriting the transaction.

Interest rate sensitivity

Having seen years of low interest rates, it was impossible for a bank not to have funded some portion of their portfolio into low fixed rate loans, which are now far below their net interest margin targets. However, those banks that have been active with SBA lending, which is almost always variable rate, have had the interest rates float up as the Federal Reserve increased rates.

Risk Mitigation

Looking ahead, as banks tighten their lending either because of liquidity issues or stricter underwriting guidelines, more borrowers will be turned away by their banks as they seek financing. SBA lending may be a way for your bank to pick up some of these clients and use the SBA guaranty to mitigate 75% of the risk of that loan.

CAMELS

It’s clear to see that SBA loans can positively influence virtually every component of your CAMELS rating. If you would like to learn more about how to grow this part of your institution, please reach out to us at Total SBA and learn how we can make SBA lending a successful part of your bank.

For more information about profitability and revenue generation, download this one-pager.

Article by: Brian Carlson

The simple way to create a profitable SBA department.

Many financial institutions are now seeing higher demand from their clients for SBA loans, due to the highly popular SBA PPP program. Considering the high demand, those lenders that do not have experienced SBA staff to fund loans are missing out on an opportunity to build their client base. This issue must be addressed, especially considering that SBA lending is one of the more profitable lending activities that a financial institution can offer.

Wouldn’t it be great to have a variable-cost SBA department just down the hall that reports to you and has the expertise to handle your SBA loan requests efficiently and accurately from start to finish? Total SBA is that solution—while we may not be down the hall, we are only a phone call or email away.

How does the SBA loan process work?

The keys to creating a profitable SBA department include loan sourcing, underwriting, processing, closing, and servicing. Let’s review this process in more detail and see how Total SBA can make your strategic goal of SBA lending a reality. 

Sourcing SBA loans   

Total SBA has a network of referral sources to assist in finding quality SBA loans nationwide. We will work with you to understand the types of loans that best fit your credit model and geography so that we can provide a fresh influx of business to your door.

But maybe you have been trying to get your commercial lending staff to generate SBA loans without success. The reality is that most loan officers aren’t experienced with SBA and, accordingly, are hesitant to take a borrower in that direction. The result is that you lose that client and potential income. We are able turn that loss around.

• The Total SBA solution is to give your team proper training on SBA rules and regulations, so they are better equipped to identify SBA loan prospects.

• We also provide simple step-by-step instructions on how to hand off a loan to Total SBA.

• As your SBA department, we handle 95% of the work to get the loan from initial contact to closing. 

Underwriting & Processing

Our team has over 100 years of combined experience and is dedicated to efficient, accurate, and friendly customer service. We work with your lending staff to assist in gathering the necessary borrower information to underwrite the loan request. We will do a complete underwriting of both the credit aspects of the loan and all the SBA eligibility requirements. We provide your institution with a complete credit memorandum for your review and due diligence.

Once the lender has approved the loan request, we prepare the SBA loan application and submit your loan to SBA for approval. Once approved, we will do everything—pull together all the necessary documentation, searches, insurance, etc.—to get your loan closed and fully funded.

SBA loan sales and profitability

SBA loans have a 75% government guaranty that can be sold on the secondary market.  This market is very active, and currently, a lender can sell the guarantees for as much as 12% net to the bank. If your team can generate the $5 million in SBA loans, the 75% that is sellable would be $3,750,000 and at a 12% premium, you will generate a $450,000 gross profit on the sale. In addition, when you sell the loans, the investor buys the guarantee at a 1.0% discount from the note rate, so the bank will continue to receive 1.0% on the sold portion, which in this example looks like: $3,750,000 X 1.0% = $37,500 in annual servicing income.

Servicing

Once the loan is closed, the lender will still need to treat their SBA portfolio differently from a conventional, commercial term loan. Unfortunately, most financial institution core systems do not accommodate SBA loans very well, so Total SBA has a solution for this as well: we will handle the loan accounting and prepare the monthly 1502 report to SBA’s Fiscal Transfer Agent, Guidehouse.  We can also take care of SBA’s servicing requirements related to any possible modifications or changes to the loan. With SBA lending, it is critical that the servicing area be handled by a team with the proper experience.

Conclusion

As you can see, SBA lending can add an invaluable additional income stream to your bank. However, you have to train your lending team and provide them with an underwriting, processing, and servicing team that they will have confidence in. Total SBA allows your institution to immediately obtain an experienced SBA backroom and avoid upfront or overhead costs. With the current high demand from business owners for SBA financing, it is important for your institution to have an SBA solution ready to better serve its business community.

Article by: Brian Carlson